The Euromarkets are the single most important source of commercial loan funds for the developing countries. The development and operation of Eurocurrency markets have played a very significant role in the post war international financial system. Indeed the explosive growth in international banking and bank lending could not have come about but for the Eurocurrency markets. Simply stated, the term Eurocurrency refers to a currency deposited in a bank outside the home country of that currency. Therefore, Eurocurrencies and Eurocurrency markets are outside the regulatory framework of any monetary authority-the monetary authority of the place where the deposit is made is not concerned with non-residents depositing or borrowing foreign currencies, which does not affect the domestic money supply. It is also outside the control of the monetary authority of the home country of the currency concerned because the transaction takes place outside the country. Inter-Bank Markets Apart from customer transactions, Continue reading
International Business Finance
Managing Foreign Exchange Risk with Forex Market Hedge
A firm may be able to reduce or eliminate currency exposure by means of Forex market hedging. Important Forex market hedging tools used for managing Forex risk are : 1. Hedging Through Options Market: Buying a Call option in Forex can be used by an importer or borrower to hedge his payables against exchange rate fluctuations. This is done only if is felt that the foreign currency is in an appreciation mode. Buying a Put option can be used by an exporter or lender to hedge receivables. This is done only when the foreign currency is in a depreciating mode. Buying a Call. Illustration: It is now August. Suppose a US importer has to pay in November 62.5 million yen to a Japanese supplier. The current $/Yen = $0.007739. A December call option in yen is available at a strike of $0.0078, per yen. The premium is $ 0.000108/yen. The Continue reading
Economic Exposure of Foreign Exchange Risk
Economic exposure is concerned with the present value of future operating cash flows to be generated by a company’s activities and how this present value, expressed in parent currency, changes following the foreign exchange rate movements. The concept of economic exposure of foreign exchange risk is most frequently applied to a company’s expected operating cash flows from foreign operations, but it can equally well be applied to a firm’s home territory operations and the extent to which the present value of those operations alters resultant upon changed exchange rates. For the purpose of convenience, the exposition that follows is based on a firm’s foreign operations. Some experts classify transaction exposure as a subset of economic exposure. They take this view arguing that the present value of an uncovered foreign currency denominated receivable or payable will vary as exchange rates vary. Whilst we accept the logic of this view, in this Continue reading
Exposures to Exchange Rate Fluctuations
International business is facilitated by markets that allow flow of funds between countries in different currencies. Multinational corporations are involved in international trade and receive and pay in various currencies. MNCs must constantly monitor exchange rates because their cash flows are highly dependent on them. The risk faced by these companies due to exchange rate movements after having already entered into financial obligations is called exchange rate risk. Such exposure to fluctuating exchange rates can lead to major losses for the firms. Exchange rate fluctuations cannot be forecast with accuracy. However, using various techniques, the amount of exposure can be measured and minimized. Exchange rate fluctuations can be broadly categorized into three types: Transaction exposure Economic exposure Translation exposure Transaction exposure arises when a firm’s contractual cash flows are affected by fluctuations in exchange rates of the currencies in which they are designated. Transaction exposures can have a great impact Continue reading
Internal Strategies for Managing Forex Transaction Risk
Transaction risk arises from executed contracts resulting in Forex payables or receivables in the future. The domestic currency value of these payables or receivables at current exchange rate and at future exchange rate is expected to be at variance, resulting in transaction risk. The forex transaction risk can be hedged using internal strategies. Internal strategies refer to strategies that are internal to the firm and its affiliates. These are “home’ arrangements. The counter party to the transactions may be involved. But third parties are never involved. The different internal strategies used for managing forex transaction risk are: Risk Netting: This strategy involves matching forex receivables in a currency with forex payables in that currency. Both currency and time matching are needed. Suppose an US firm has Yen 10 mn receivable from and Yen 7 mn payable to same counter party, both having 90 days to mature. These two transactions can Continue reading
Difference Between Letter of Credit and Guarantee
A letter of credit is a written undertaking issued by buyer’s bank to pay a certain sum of money within a stipulated period against a specified set of documents. It is a conditional undertaking. It undertakes to pay a certain amount of money on presentation of stipulated documents and the fulfillment by the exporter of all the terms and conditions incorporated in the L/C. The Letter of credit is a separate and distinct contract from the underlying sale contract, and the bank is not responsible for the fulfillment of the terms of the sale contract. The essential and basic provisions of the sale contract must be incorporated in the letter of credit. In addition, the amount of credit, its expiry date, the tenor of the draft to be drawn, party on whom the draft is to be drawn, the documents to be presented, brief description of the goods, must be Continue reading